Bitcoin: Speculative Investment Or The Future Of Currency?

Bitcoin is a highly volatile and speculative investment. Its price is extremely sensitive to market behaviour, and its value is not based on traditional metrics. Bitcoin's price swings are commonplace, and it is not a legal tender currency. It is a digital currency that operates independently of governments and banks, and its value is derived from the complex algorithms that generate it. Bitcoin's popularity stems from its ability to provide high returns and its independence from traditional financial systems. However, it is essential to approach Bitcoin with caution, as its value can fluctuate dramatically, and it may not provide the same stability as traditional investments.

Bitcoin's extreme volatility

Bitcoin is a highly volatile, almost completely speculative investment. Its price can fluctuate wildly, as evidenced by a 20% rise in the first weekend of 2021, followed by a 20% fall the next Sunday. This volatility is due to the nature of Bitcoin as a digital currency that operates outside the control of governments and banks, and its price is determined by the market demand for it. Bitcoin's price is also influenced by its limited supply, which is predetermined by its underlying technology.

Secondly, Bitcoin is a highly technical asset, and its supply is controlled by a complex algorithm. The process of mining Bitcoin involves solving computationally intensive puzzles, and the total supply of Bitcoin is limited to 21 million. As more Bitcoins are mined, the puzzles become more difficult, and the supply growth slows down. This algorithmic control of supply can lead to sudden changes in Bitcoin's price as the market adjusts to changes in supply.

Thirdly, Bitcoin's extreme volatility is also driven by the news and global events. For example, the COVID-19 lockdowns and the resulting economic stimulus measures contributed to Bitcoin's price volatility. Additionally, regulatory changes or statements by government officials regarding Bitcoin can also impact its price significantly. For instance, the Chinese government's crackdown on Bitcoin exchanges in 2017 caused a significant drop in Bitcoin's price.

Lastly, Bitcoin's extreme volatility is fuelled by the behaviour of investors. As Bitcoin is a highly speculative asset, it attracts investors with a high-risk appetite. These investors are often quick to react to market movements and news, leading to rapid price changes. The presence of algorithmic and high-frequency traders in the Bitcoin market also contributes to its volatility, as they can execute trades at extremely high speeds, amplifying price movements.

In summary, Bitcoin's extreme volatility is a result of its unique characteristics as a decentralised and unregulated digital currency.

The regulatory risk

Bitcoin is a highly speculative investment. One of the biggest risks is the regulatory risk.

Bitcoin is a digital currency that operates outside the control of governments and banks. It is a decentralised digital currency intended to be used in buying or selling goods and services. However, its decentralised nature means that it is often used for illicit and illegal transactions, such as money laundering, financing terrorism, and buying or selling banned substances. This has led to concerns from governments and financial institutions about the need for regulation.

The regulatory landscape for Bitcoin varies globally, with some countries imposing outright bans on cryptocurrencies, while others have partial bans or no regulation at all. For example, China has prohibited registered financial institutions from engaging in cryptocurrency transactions, while Japan has allowed Bitcoin to be used as a legally accepted means of payment. In the US, various federal agencies define cryptocurrencies in different ways, leading to a lack of consistent regulation.

The lack of consistent and comprehensive regulation creates opportunities for illicit activities and market manipulation. For instance, crypto exchanges do not always fit neatly into the definitions of a money services business (MSB), allowing for anonymous transactions and the movement of illicit funds. Additionally, the top five mining pools control 64% of total hash rates, giving them significant influence over the process. This concentration of power in a handful of miners and holders goes against the early vision of a democratised and dispersed network.

To address these risks, there have been calls for enhanced cryptocurrency regulation and global standards. The Financial Stability Board, an international body that monitors the global financial system, has made recommendations for the regulation of crypto assets and stablecoins. Regulatory authorities are also taking steps to address the risks, such as the US Treasury requiring crypto exchanges to operate as MSBs under the Anti-Money Laundering Act of 2020 (AMLA 2020).

While regulation is necessary to address the risks associated with Bitcoin, it is important to balance it with the need to encourage innovation in the crypto space.

Bitcoin's limited practical use cases

Bitcoin is a highly speculative investment. Its price swings are commonplace and wild, making it a favourite of high-stakes, risk-seeking investors.

Bitcoin's practical use cases are limited. Here are some of the reasons why:

• Limited transactions per second: Bitcoin's network of miners can process a maximum of seven transactions per second, with the current rate running at around five. In comparison, Visa can process up to 65,000 payments per second. This limitation causes a backlog, resulting in higher transaction costs for customers.
• High transaction costs: The cost per transaction has been high throughout 2024, ranging from $16 to $20, and even reaching $59 on April 23 due to a flood at a coal mine in China that caused a loss of computing power. These high costs make Bitcoin impractical for everyday transactions.
• Long confirmation times: It can take up to an hour to receive confirmation for a Bitcoin transaction, which is problematic for retailers as there is a risk of loss due to price changes during this period.
• Volatility: Bitcoin's extreme volatility makes it unreliable as a store of value. For instance, after hitting an all-time peak of $64,800 on April 14, it dropped over 23% to $49,700 within a week. This volatility is four times higher than that of gold, a traditional store of value.
• No intrinsic value: Unlike gold, which has intrinsic value due to its use in jewellery and electronics, Bitcoin has no practical, money-making uses. Its value is based solely on speculation and the belief that future true believers will pay more for it.
• Regulatory risks: Regulatory crackdowns on Bitcoin and other cryptocurrencies pose a significant risk to their value. For example, the Chinese government's decision to outlaw Bitcoin exchanges in 2017 caused a tumble in prices.

The questionable legality of cryptocurrencies

The legality of cryptocurrencies is a complex and evolving issue that varies across different jurisdictions. While some countries have embraced their use, others have restricted or banned them outright. Here is an overview of the questionable legality of cryptocurrencies:

Varying Legal Status

The legal status of cryptocurrencies differs significantly from one country to another and remains undefined or subject to change in many places. While the majority of countries do not consider the use of cryptocurrency illegal, its status and usability as a means of payment or a commodity vary, leading to differing regulatory implications. Some states have explicitly permitted its use and trade, while others have imposed bans or restrictions.

Regulatory Challenges

The decentralised nature of cryptocurrencies, operating outside the control of governments and banks, poses regulatory challenges. Cryptocurrencies challenge the traditional role of banks and central banks by eliminating the need for intermediaries in transactions. This threatens the classical model of banking, where institutions provide loans from deposits and central bank funding. The absence of a central authority in the cryptocurrency system makes it difficult to implement traditional financial regulations.

Jurisdictional Issues

The distributed ledger technology underpinning cryptocurrencies makes it challenging to pinpoint a transaction's location. This feature offers greater privacy than traditional platforms but creates complex jurisdictional challenges. Crypto transactions may be subject to conflicting legal frameworks as nodes can be located in multiple jurisdictions. Additionally, determining the "residence country" for cryptocurrency software is difficult due to the lack of a physical location.

Data Theft and Financial Fraud

The promise of anonymity and limited regulations in the cryptocurrency space attracts users involved in illegal activities. Cryptocurrencies have been associated with data theft, financial fraud, and criminal enterprises. Blockchain analytic tools have been developed to trace transactions and address these concerns, but their effectiveness is still uncertain.

Taxation and Reporting

The taxation of cryptocurrencies varies across countries. In the US, the IRS classifies cryptocurrencies differently—in the US, the IRS classifies cryptocurrencies as property, not currency, for federal income tax purposes. This means that taxpayers must report transactions in US dollars and determine the fair market value of their cryptocurrencies on each transaction date. In contrast, several countries in the European Union tax cryptocurrencies as income, without applying value-added tax (VAT).

Intellectual Property and Ownership

The decentralised nature of cryptocurrencies also raises questions about intellectual property ownership and authorship. The lack of a clear regulatory framework in this area may lead to disputes and legal challenges.

Limited Legal Recourse

Since cryptocurrencies are not backed by centralised regulatory bodies or issuing authorities, investors may have limited legal resources if complications arise from their transactions or ownership. The decentralised nature of blockchain technology means that there is no established mechanism to resolve disputes, and victims of cryptocurrency theft may have no legal avenue for compensation.

The role of bitcoin in transmitting monetary policy

Bitcoin is a highly volatile, almost completely speculative investment. Its price is extremely sensitive to changes in monetary policy, and this sensitivity has evolved over time.

Bitcoin is a digital currency that operates outside the control of governments and banks. It can be traded directly between two parties or on independent exchanges. Trading it is fast and cheap. Its volatile price, found by looking at BTCUSD, has made it a favourite of high-stakes, risk-seeking investors eager for the potential of a big payoff.

The impact of monetary policy on Bitcoin has evolved over time. Since 2020, Bitcoin prices fall immediately after Fed tightening. In contrast, historically, Bitcoin prices used to rise in the aftermath of tight policy. This shift may be due to the broadening of the investor base after the COVID-19 outbreak.

Bitcoin prices respond to monetary news similarly to other risky assets like stocks, foreign exchange, and gold. However, Bitcoin valuations are even more strongly affected by monetary policy than these other assets.

The demand for Bitcoin is driven by its ability to facilitate decentralised electronic value transfer. It is also driven by its potential to function as an inflation hedge, though this has been less significant recently.

Bitcoin's role in transmitting monetary policy is complex and evolving. Its impact on the financial system and regulatory policy is significant and continues to grow.

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